Section 36(b) of the Investment Company Act of 1940 imposes on investment advisers “a fiduciary duty with respect to the receipt of compensation for services” from a mutual fund, and gives fund shareholders a private right of action for breach of that duty. 15 U.S.C. § 80a-35(b). The Act further provides that, in such an action, “approval by the [fund’s] board of directors” of the fee paid “shall be given such consideration by the court as is deemed appropriate under all the circumstances.” Id. § 80a-35(b)(2). In a unanimous opinion by Justice Alito, the Supreme Court today held that to face liability under Section 36(b), an investment advisor must “charge a fee that is so disproportionately large that it bears no reasonable relationship to the services rendered and could not have been the product of arm’s length bargaining.” Slip op. 9.

In so holding, the Court adopted a test that was first articulated in Gartenberg v. Merrill Lynch Asset Management, 694 F.2d 923 (2d Cir. 1982). But today’s opinion is more than a mere affirmation of the Gartenberg standard. The Court’s explication of how that standard is to be applied makes clear that plaintiffs face a formidable hurdle when asserting a claim under §36(b).

The plaintiffs in Jones own shares in several funds advised by Harris Associates L.P., the defendant. Plaintiffs contend that Harris Associates was paid excessive fees in violation of Section 36(b). Relying on the Gartenberg standard, the district court granted summary judgment to the defendant. A panel of the Seventh Circuit affirmed on different grounds, explicitly “disapproving the Gartenberg approach.” Id. In today’s decision, the Supreme Court vacated and remanded, directing the Seventh Circuit to apply the Gartenberg standard. Id. at 17.

Today’s opinion by Justice Alito leaves no doubt that courts applying the Gartenberg standard owe considerable deference to the compensation decisions made by the defendant fund’s board of directors. For example, the opinion emphasizes that “the standard for fiduciary breach under 36(b) does not call for judicial second-guessing of informed board decisions” and that courts may not “supplant the judgment of disinterested directors apprised of all relevant information, without additional evidence that the fee exceeds the arm’s-length range.” Id. at 16. Thus, as Justice Thomas notes in his concurrence, what the Court endorsed is not “the free-ranging judicial ‘fairness’ review of fees that Gartenberg could be read to authorize” but a much more measured approach “that defers to the informed conclusions of disinterested boards and holds plaintiffs to their heavy burden of proof.” Concurrence at 1–2.

Mayer Brown filed an amicus brief in support of the Jones respondent at the merits stage.

The False Claims Act contains a “public disclosure bar” that deprives courts of jurisdiction over qui tam actions that are based on information that already has entered the public domain. 31 U.S.C. § 3730(e)(4)(A). This provision applies to disclosures that were made in, among other sources, an “administrative” report, audit, or investigation. Today, the Supreme Court held that the word “administrative” is not limited to federal sources, but also includes disclosures that were made in state and local proceedings.

In this case, both the county and the state of North Carolina had published reports detailing the purported fraud at issue in the relator’s action. The district court found that the lawsuit was predicated on those reports. Holding that the local and state reports constituted administrative reports within the meaning of the False Claims Act, the district court dismissed the suit for lack of jurisdiction. The Fourth Circuit reversed, reinstating the suit on the ground that the public disclosure bar applied only to information disclosed in federal forums. In today’s decision, the Supreme Court reversed the Fourth Circuit and affirmed dismissal of the suit.

The majority opinion, authored by Justice Stevens, found no textual basis in the False Claims Act for limiting the term “administrative” reports to those produced by federal sources. Moreover, the Court found that viewed as a whole the public disclosure provision—which, for example, also precludes qui tam suits based on information taken from the “news media”—supports a broader interpretation of the public disclosure bar. In concluding that the bar applies to information contained in state and local reports, the Court rejected the contention that its reading of the statute was contrary to Congress’s intent, noting that Congress had “preserved the rights of the most deserving qui tam plaintiffs: those whistle-blowers who qualify as original sources.”

Justice Scalia concurred in part and concurred in the judgment. Justice Scalia agreed with the Court that the text of the statute was not limited to federal sources, and thus he found it “utterly irrelevant whether the Members of Congress intended otherwise.” Justice Sotomayor, joined by Justice Breyer, dissented.

As the Court observed in footnote 1 of the opinion, the recent passage of the Patient Protection and Affordable Care Act has altered the language contained in 31 U.S.C. § 3730(e)(4)(A). Thus, the significance of today’s decision may be limited.

Mayer Brown filed amicus briefs in support of the Graham County petitioners at the cert and merits stages.

Mayer Brown's Supreme Court & Appellate practice distributes a Docket Report whenever the Supreme Court grants certiorari in a case of interest to the business community and distributes a Docket Report-Decision Alert whenever the Court decides such a case. We hope you find the Docket Reports and Decision Alerts useful, and welcome feedback on them (which should be addressed to Andrew Tauber, their general editor, at atauber@mayerbrown.com or +1 202 263 3324).

Feel free to forward this message to anyone who you believe might be interested in the Decision Alert.

Mayer Brown Supreme Court Docket Reports provide information and
comments on legal issues and developments of interest to our clients and
friends. They are not a comprehensive treatment of the subject matter covered
and are not intended to provide legal advice. Readers should seek specific
legal advice before taking any action with respect to the matters discussed.

Mayer Brown is a global legal services provider comprising legal practices that are separate entities (the “Mayer Brown Practices”). The Mayer Brown Practices are: Mayer Brown LLP and Mayer Brown Europe – Brussels LLP, both limited liability partnerships established in Illinois USA; Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales (authorized and regulated by the Solicitors Regulation Authority and registered in England and Wales number OC 303359); Mayer Brown, a SELAS established in France; Mayer Brown JSM, a Hong Kong partnership and its associated entities in Asia; and Tauil & Chequer Advogados, a Brazilian law partnership with which Mayer Brown is associated. “Mayer Brown” and the Mayer Brown logo are the trademarks of the Mayer Brown Practices in their respective jurisdictions.